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Tax Credits of Dubious Value
Tuition Help for Middle Class Can Backfire, Study Says

By Albert B. Crenshaw
Washington Post Staff Writer
Sunday, May 20, 2001; Page H02

Back in 1997, as outcries from middle-class families about the high cost of college reached a crescendo, the Clinton administration hustled through Congress a package of tax credits aimed at easing their pain.

The Hope and Lifetime Learning credits offered to reduce a family's taxes by as much as $1,500, depending on how much tuition the family pays and which credit it takes. And while that doesn't go far toward the $35,000 or so it costs to go to Harvard or Yale, it is a significant offset to in-state tuition at most public colleges.

The credits were good politics -- President Clinton proposed them during his 1996 reelection campaign as a counter to Republican candidate Robert J. Dole's tax-cut proposal -- and middle-class families have been scarfing them up. The congressional Joint Committee on Taxation figures they will cost the federal government $21.4 billion from 2001 to 2005.

But is this the best use of federal education funds? And are middle-class families really better off?

Critics said at the start that the credits were dubious as policy and that their benefits to the middle class might well prove ephemeral. Now a new study, focused on the Hope credit, concludes that the critics were right.

"The Hope [credit] squanders a substantial sum of federal tax resources" while failing to deliver significant benefits to individuals, colleges, states or the federal government, says the study, written by former Clinton education policy adviser Thomas R. Wolanin, now with the Institute for Higher Education Policy, a nonprofit group here.

To begin with, the credits are of little value to families with little income. While credits, which reduce taxes dollar for dollar, are better than deductions, whose value varies with the taxpayer's tax bracket, these credits are not refundable, so families with modest tax liabilities are not likely to get the full benefit.

In addition, they are applicable only to tuition "and related expenses." Thus students who attend community colleges, where tuition is low, also don't get the full benefit, but they still have expenses such as transportation and living costs.

Those are public policy issues, however, and may well be dismissed by middle-class families as "not our problem."

But Wolanin points to an effect that could, in fact, be a problem for the middle class. It is the same issue that arises with such subsidies as the mortgage-interest deduction and lower mortgage interest rates provided by Fannie Mae and Freddie Mac:

Does the subsidy make the product more "affordable," or does it simply enable buyers to pay a higher price? If it is the latter, the benefits of the subsidy flow not to the buyer (the student and the student's family, in the case of tuition credits) but to the seller (the college).

The effects are hard to sort out, but remember that when interest in a no-deduction flat tax was at its zenith a few years ago, home builders complained that elimination of the mortgage-interest deduction would cause home prices to fall. This suggests that the benefit, in that case at least, is to the sellers, who can ask a higher price because they have both real estate and tax benefits to sell.

The law forbids consideration of either the Hope or Lifetime credit in calculating federal aid, but that doesn't prevent states and individual schools from taking the credits into account in their aid formulas.

The Hope credit creates an incentive to raise tuition and lower aid, Wolanin says.

"Tuition increases and student aid decreases are analytically two sides of he same coin," he says in the report. Among private colleges, "the incentive effect of the Hope [credit] is more likely to be manifest in decreases in the amount of student aid otherwise available," he says.

One key reason for this, he says, is that "the culture of the student aid process at private colleges . . . places a premium on stretching institutional aid resources as far as possible, which is to say not giving students any more than necessary of what otherwise would be tuition revenue. One important way to accomplish that goal is to take into account as fully as possible all of the resources available to students and their families. This would obviously include taking into account" the Hope credit.

It's hard to tell how much that is actually happening, but Wolanin points to one private-school aid official who said: "The fact is that families that receive $1,500 from the federal government are better off than those that don't. And I don't think we can ignore that."

Interest among states is more out in the open, Wolanin says, and there "the incentive effects are stronger and the consequences more important."

He points to several states whose legislative bodies have considered taking the credits into account in their financial aid policies, including Louisiana, which rejiggered an aid program "in an attempt to substitute Hope [credit] funds for state funds in a scheme characterized as 'blind greed' on the part of the state."

Since this process is likely to take some time, today's students and those attending college in the next few years probably will realize greater benefit than those in the more distant future when the credit is more fully integrated into aid and tuition.

And in any case, families should make sure they take the credit if they are eligible. The Hope credit is worth $1,500 a year for the first two years of college, and the Lifetime credit is worth up to 20 percent of the first $5,000 -- in other words, $1,000 -- a year, and it may be claimed for an unlimited number of years. The maximum Lifetime credit will rise to $2,000, beginning in 2003.

The credits are fully available to families with adjusted gross incomes of less than $80,000 for a joint return, phasing out between $80,000 and $100,000. (The limits are $40,000 to $50,000 on a single taxpayer's return.) It can be claimed by parents if a student is a dependent on their return.

The credits can also benefit wealthier families because students with taxable income may claim the credit.

Thus, a family in which the parents are over the income limit but who have been placing income-producing assets in the child's name may find it advantageous to have the child take the credit. In such a case, the parents would have to take the child off their return, thus forfeiting the dependency deduction, but they may find that the family's total tax bill will still be lower with the child taking the credit.

Such families need to run the numbers both ways to see which is better -- which makes the credits good for accountants as well.

(Original Len: 7679 Condensed Len: 7990)

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